Tuesday, October 21, 2008

Martin Feldstein On The Money Supply and Current Crisis

Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan and the George F. Baker Professor of Economics at Harvard University, recently penned a WSJ Op-Ed calling for a program to stop a downward overshooting of house prices and the resulting mortgage defaults. A mortgage-replacement loan program may be the best way to achieve that, he wrote.

Since the latest leg of the downturn in the mortgage market, and now the overall economy, seems to be the result of the fact that the Federal Reserve crashed money supply growth over the summer, I have often wondered what Feldstein's take was on the Fed's activities this summer. I got the chance to ask him. Feldstein was a part of a panel that included Wilbur Ross Jr., Juan Williams and Ron Insana, before 4,000 at the AFP conference.

During the panel discussion, Feldstein stated that the Federal Reserve was doing an excellent job providing liquidity to the system but it wasn't working and that is why further measures, such as his "mortgage-replacement loan program" needed to be implemented.

During the Q & A, I asked him how he could say that the Fed was providing liquidity to the system since M2 growth crashed over the summer from a March peak of 12.5% annualized growth to growth of only 1.5% annualized in September. I further stated to him that, in addition, over the summer the Fed was sterilizing the cash infusions they were making by selling off Treasury securities, thus maintaining a net liquidity neutral stance as part of its various rescue operations.

Feldstein did not answer the question about where he saw liquidity coming from the system over the summer( How could he, since there wasn't any net liquidity added to the system?), but he did address the fact that money growth slowed over the summer. He said it likely occurred because of the problems in the economy (which in his view apparently took time for the Fed to adjust too.) He then said that money supply M2 was back growing at an annualized rate of 4.5%, which was correct. He said that this was about the correct growth rate given current GDP growth. This is a hoot, since money supply in September was at 1.5% annualized, and it then jumped to 2.3%, and now is at 4.5%, the Fed clearly has its foot on the monetary accelerator. I don't believe money supply at 4.5% is anything but a very brief transition point. Within weeks money supply growth could be at double digit rates. Indeed, the money supply numbers due out this Thursday could show M2 growth much higher than 4.5%. Feldstein clearly hasn't figured out that Ben Bernanke's Fed is clueless. When he does, I wonder what his prescription for the economy will be?

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